Topic on Corporate Governance

1. 11-1© 2006 by Nelson, a division of Thomson Canada Limited.
Corporate Governance
Chapter Eleven

2. 11-2© 2006 by Nelson, a division of Thomson Canada Limited.
The Strategic .
Management .
Process
The Strategic Management
Process
Chapter 5
Bus. - Level
Strategy
Chapter 6
Competitive
Dynamics
Chapter 9
International
Strategy
Chapter 10
Cooperative
Strategies
Chapter 8
Acquisitions &
Restructuring
Strategic
Inputs
StrategicActions
Strategic
Outcomes Chapter 4
Internal
Environment
Chapter 3
External
Environment Strat. Intent
Strat. Mission
Strategy Formulation
Strategic
Competitiveness
Chapter 1
Above Average
Returns
Chapter 2
Strategic
Competitiveness
Chapter 1
Chapter 7
Corp. - Level
Strategy
Chapter 5
Bus. - Level
Strategy
Chapter 11
Corporate
Governance
Chapter 12
Structure
& Control
Chapter 13
Strategic
Leadership
Chapter 14
Entrepreneurship
& Innovation
Strategy Implementation
Feedback
Chapter 11
Corporate
Governance

3. 11-3© 2006 by Nelson, a division of Thomson Canada Limited.
Corporate Governance
Knowledge objectives:
1. Define corporate governance & explain why it is used
to monitor & control managers’ strategic decisions.
2. Explain how ownership came to be separated from
managerial control in the modern corporation.
3. Define an agency relationship & managerial
opportunism & describe their strategic implications.
4. Explain how three internal governance mechanisms –
ownership concentration, the board of directors and
executive compensation – are used to monitor &
control managerial decisions.

4. 11-4© 2006 by Nelson, a division of Thomson Canada Limited.
Corporate Governance
Knowledge objectives cont’d…
5. Discuss trends among the three types of compensation
executives receive and their effects on strategic
decisions.
6. Describe how the external corporate governance
mechanism – the market for corporate control - acts as
a restraint on top level managers strategic decisions.
7. Discuss the use of corporate governance in
international settings, in particular in Germany &
Japan.
8. Describe how corporate governance fosters ethical
strategic decisions & the importance of such
behaviours on the part of top-level executives.

5. 11-5© 2006 by Nelson, a division of Thomson Canada Limited.
Corporate Governance is a relationship among stakeholders
that is used to determine and control the strategic direction &
performance of organizations.
Concerned with identifying ways to ensure that strategic
decisions are made effectively.
Used in corporations to establish order between the firm’s
owners and its top-level managers.
Corporate Governance

6. 11-6© 2006 by Nelson, a division of Thomson Canada Limited.
Ten most admired & respected corporations in Canada

7. 11-7© 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms

8. 11-8© 2006 by Nelson, a division of Thomson Canada Limited.
Separation of Ownership & Managerial Control
Basis of the modern corporation
Shareholders purchase stock, becoming
Residual Claimants
Professional managers contract to provide
decision-making.
Modern public corporation form leads to efficient
specialization of tasks.
Shareholders reduce risk efficiently
by holding diversified portfolios.
Risk bearing by shareholders.
Strategy development and decision-making
by managers.

9. 11-9© 2006 by Nelson, a division of Thomson Canada Limited.
Agency
Relationship
Risk Bearing Specialist
(Principal)
Managers
(Agents)
Decision
Makers
which createswhich creates
Managerial Decision-
Making Specialist
(Agent)
Hire
An agency relationship exists when:
Shareholders
(Principals)
Firm Owners
Agency Theory

10. 11-10© 2006 by Nelson, a division of Thomson Canada Limited.
The Agency problem occurs when:
The desires or goals of the principal & agent conflict
and it is difficult or expensive for the principal to verify
that the agent has behaved appropriately.
Example: Over - diversification: Greater product
diversification leads to lower management
employment risk & greater compensation.
Solution: Principals engage in incentive-based
performance contracts, monitoring mechanisms
like the board of directors & enforcement
mechanisms like managerial labour market to
mitigate agency problems.
Agency Theory

11. 11-11© 2006 by Nelson, a division of Thomson Canada Limited.
Product Diversification as an example of an
Agency Problem
• Diversification usually increases the size of the
firm – therefore complexity and an opportunity
for top executives to increase their
compensation.
• Diversification usually reduces top executives’
employment risk.
• Top executives have control over free cash flow
and may invest in in products not associated
with the firm’s current lines of business.

12. 11-12© 2006 by Nelson, a division of Thomson Canada Limited.
Risk
Level of Diversification
Dominant
Business
Unrelated
Businesses
Related
Constrained
Related
Linked
Managerial
(Employment)
Risk Profile
M
B
Shareholder
(Business)
Risk Profile
S
A
Manager & Shareholder Risk & Diversification

13. 11-13© 2006 by Nelson, a division of Thomson Canada Limited.
Agency Costs & Governance Mechanisms
• Managerial interests may prevail when governance
mechanisms are weak.
• If the board of directors control managerial
autonomy, the firm’s strategies should better reflect
the interests of the shareholders.

14. 11-14© 2006 by Nelson, a division of Thomson Canada Limited.
Governance Mechanisms
Ownership Concentration
- Large block shareholders have a strong incentive to
monitor management closely.
In Canada such shareholders account for 65% to 70% of
publicly traded stocks (59% in the U.S.)
- Their large stakes make it worth their while to spend time,
effort & expense to monitor closely.
- Institutional owners are financial institutions such as
stock mutual funds and pension funds that control large-
block shareholder positions.

15. 11-15© 2006 by Nelson, a division of Thomson Canada Limited.
Insiders
Outsiders
Boards of Directors
- Set compensation of CEO & decide when to
replace the CEO.
- Formally monitor & control the firm’s top-
level executives.
- May lack contact with day to day operations.
A firm’s CEO & other top-level managers
Related
Outsiders
Individuals not involved with a firm’s day-to-
day operations, but who have a relationship
with the company
Individuals independent of a firm’s day-to-
day operations and other relationships
Governance Mechanisms

16. 11-16© 2006 by Nelson, a division of Thomson Canada Limited.
Accountability of Board Members
• Increased diversity amongst board members.
• The strengthening of internal management &
accounting control systems.
• The establishment & consistent use of formal
processes to evaluate board’s performance.
• Directors are being required to own significant
equity stakes as a prerequisite to holding a
board seat.

17. 11-17© 2006 by Nelson, a division of Thomson Canada Limited.
Executive Compensation
Executive compensation: A governance
mechanism aligning the interests of managers
& owners through salaries, bonuses and long
term incentives such as stock options.
Stock options: A mechanism which links the
executive’s performance to the performance of
the company.

18. 11-18© 2006 by Nelson, a division of Thomson Canada Limited.
Table 11.4

19. 11-19© 2006 by Nelson, a division of Thomson Canada Limited.
Table 11.5

20. 11-20© 2006 by Nelson, a division of Thomson Canada Limited.
Market for Corporate Control
An external governance mechanism that becomes
active when a firms internal controls fail which is
triggered by a firm’s poor performance, relative
to industry competition.

21. 11-21© 2006 by Nelson, a division of Thomson Canada Limited.
A Basic List of Management Defence Tactics
Increase the costs of mounting a takeover and can
entrench current management.
Greenmail
Where company money is used to repurchase stock from
a corporate raider to avoid takeover.
Golden Parachute
Raises the cost of making changes at a take-over target due
to the need to pay fired executives large severance packages.
Poison Pill
When the takeover target does something to make itself
unpalatable to the suitor (e.g. assume a large amount of
debt and then issue dividends with the money).

22. 11-22© 2006 by Nelson, a division of Thomson Canada Limited.
Governance Mechanism & Ethical Behaviour
• Shareholders are recognized as a company’s most
significant stakeholders.
• The minimum interests or needs of all stakeholders must
be recognized through the firms actions.
• A firm’s strategic competitiveness is enhanced when its
governance mechanisms take into consideration the
interests of all stakeholders.
• Only when the proper corporate governance is exercised
can strategies be formulated & implemented that will
help the firm achieve strategic competitiveness & earn
above average returns.